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We investigate the effects of market fragmentation and information flows in the case of stocks cross listed on markets in Central Europe and London. First, we test for co-movement, interaction and error correction behavior between the local and London markets. Our results suggest that strong interactions exist between these markets, with the London market being slightly more important than the local one. The two prices of cross-listed stocks are cointegrated and pricing errors are corrected over few days. These interactions suggest partial fragmentation. Second, we extend an earlier model to examine the impact of foreign listing on the variance of local returns. The focus of previous studies has concentrated almost exclusively on the return of cross-listed securities. The variance of returns has remained mostly unnoticed, even though some studies noted an increase of variance after the cross listing. In our model, we introduce a new factor that influences return variance – tighter interaction with foreign markets as a consequence of cross listing. Estimation results lend support to our model.

Cross listing of securities has been increasingly popular in recent decades and the number of ADR and GDR issues has been growing fast. Indeed, even firms from transition economies – that have limited equity market experience – introduced their stock to the international equity markets in London or New York. With growing popularity of cross listing in the financial markets, economic literature started to pay closer attention to this phenomenon.

The focus of majority of previous studies has concentrated on the excess return connected with cross listing. The second most important characteristic of a stock – its risk as measured by return variance – has been largely neglected and the present paper attempts to fill this gap. First, we investigate the information flows between cross-listed securities and draw a conclusion about the degree of integration of the local and foreign markets. Second, we turn to the problem of local return volatility. We extend an earlier model of Domowitz et al. (1998) and estimate it using data on stocks from Central Europe that are cross-listed on the London Stock Exchange. We explicitly include the pricing errors between the local and London markets as a factor influencing the beliefs of market participants. Approximately half of the stocks in our sample allow us to estimate the effects of cross listing directly, in an event-study manner, for the rest we estimate a simplified version of the model.

In the first step of our analysis, we attempt to determine whether and to what extent are the information flows between local and foreign markets important. For this purpose, we use the Granger causality framework and a cointegration/error correction approach.

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